Are New Zealand banks approving liar loans?

by Graham Adams / 09 May, 2018

Safe as houses? How confident can we be that New Zealand's $248b mortgage market is as sound as the banks say it is? Photo / Getty Images

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Lax mortgage controls are possibly the most damaging revelation from Australia’s royal commission. An inquiry here could assess whether our lending “culture” is truly different.

When Alan Greenspan was chairman of the Federal Reserve he made it his abiding mission to remain unintelligible. In fact, he was so dedicated to being obscure he once famously remarked: “Since becoming a central banker, I have learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said.”

Adrian Orr, the fresh governor of New Zealand’s Reserve Bank, may wish he were not quite so garrulous or so easily understood. Just a fortnight ago, he was telling TVNZ’s Q&A that there was no need for a banking inquiry here because of the “cultural” differences between New Zealand’s financial institutions and those in Australia — which are currently being roasted at the spectacular Royal Commission hearings in Melbourne. 

Two weeks is obviously a long time in banking. Orr’s previous certainty about our cultural purity suddenly looks less certain. Late last week, he joined Rob Everett, the CEO of the Financial Markets Authority, in sending a stern letter to New Zealand’s licensed banks warning them to come clean about any conduct that might have had “detrimental outcomes for customers” — ie, the kind of failings he was so certain they didn’t need to investigate just a few weeks ago. 

This fishing expedition looks either like shameless posturing to appease the critics who are agitating for a banking inquiry or the result of a Road to Damascus experience about the possibility of banks misbehaving here.

Orr’s “cultural differences” argument was always going to be hard to maintain given that — as the letter concedes — “the obvious cross-over [with Australia] in terms of entities, people and practices into New Zealand demands a strong response”.

The banks have until May 18 to convince the regulators they behave differently to the Australian banks, including reporting on remedial work they are already doing in areas of concern.

Some of the extraordinary revelations at the Royal Commission hearings will presumably be easy for our banks to dismiss as a feature of their own practices. You’d hope they would be able to credibly assert that their clients are all alive and they aren’t charging dead people for services; or offering loans of more than $500,000 to 80-year-olds with poor English; or using gym owners to funnel clients their way — which are some of the more colourful practices revealed in Melbourne.

What is more important will be their ability to show that they haven’t been approving large numbers of “liar loans”. The practice of overstating income and minimising expenses in order to qualify for gigantic mortgage loans has turned out to be potentially the most damaging of the revelations at the Royal Commission inquiry, not least because risky lending can threaten the stability of individual banks and the financial system overall.

What grabbed headlines about “liar loans” in Australia was the astonishing estimate last year by global financial services firm UBS that almost a third of Australian mortgages — worth around $A500 billion — may be risky.

The testimony at the Royal Commission in no way indicated UBS's concerns about liar loans were misplaced. ANZ, for one, acknowledged evidence was lacking that it had made genuine inquiries into customers’ living expenses.

William Ranken, who was responsible for ANZ's home loan portfolio in Australia, stated that in the year to September 2017, ANZ wrote $A67 billion in home loans with 56 per cent ($A38 billion) coming from mortgage brokers. He admitted that ANZ did not verify the information from brokers regarding customers’ outgoings, even when declared living expenses were “inconsistent” with information that ANZ holds, such as bank statements. 

Given that around 40 per cent of mortgage lending in New Zealand is done through brokers, you might wonder which of our regulatory agencies have been ensuring the same problems haven’t arisen here.

As a handy guide, the regulation of our banks and financial institutions is divided between the Reserve Bank, which is responsible for monitoring and evaluating banks’ lending practices in respect of prudential aspects; the FMA, which does the same in respect of market conduct; and the Commerce Commission, which oversees fair lending practices.

When NOTED asked the Reserve Bank, it became clear it wasn’t an area the bank covers closely.

“From the broad and deep set of indicators that we get from banks, we can and do slice and dice the information in many different ways to analyse what is happening with a bank’s lending. Our analytical work won’t show whether or not a single specific loan or customer has an issue or problem but will point to bigger issues or systemic problems happening within a bank. That’s our remit so that’s what we monitor — making sure that there are no systemic issues or problems in the financial system. Our analysis hasn’t indicated to us that ‘liar loans’ are a significant issue in New Zealand.”

In answer to the specific question of whether the Reserve Bank has assessed a sample of loans (which is how UBS came up with their alarming figures in Australia), the bank replied: “No, we have not. We generally don’t get deep into hands-on audits like that.”

The FMA was categorical when asked if it looked into bank lending practices. “No. It’s not in our remit.”

The Commerce Commission replied that it “has not investigated whether NZ banks are writing ‘liar loans’ in which borrowers or mortgage brokers are fudging borrowers’ expenses, debt and income. We do not have a complaint base about such practices.

“Under the CCCFA [Credit Contracts and Consumer Finance Amendment Act], lenders are entitled to rely on information provided by borrowers unless they have reasonable grounds to believe that the information is not reliable. So, it is not the case that lenders are always bound to seek to independently verify the information supplied on behalf of borrowers.”

In short, it appears none of our regulatory agencies keeps a close watch on the detail of banks’ lending practices.

Geof Mortlock, a banking consultant who has held senior roles in the Australian Prudential Regulation Authority and the NZ Reserve Bank, alongside considerable international experience, thinks the Reserve Bank should be more proactive in this area, particularly because lax lending standards are a major cause of bank failures.

Mortlock: “The RBNZ, as prudential supervisor, should, if it were doing its job properly, assess banks’ lending practices for the purpose of ensuring that sound credit risk management is being maintained, given that inadequacies in that regard have a major bearing on banks’ capital adequacy. Indeed, most bank failures globally (including in New Zealand) are attributable to poor lending standards. 

“In that regard, the RBNZ should be assessing the extent to which banks have reliable ways of ensuring that they capture accurate data from prospective borrowers in the loan application process and via broker channels, given that this will have a significant influence on their ability to assess credit risk (i.e. the borrower's capacity to service the loan).

“The RBNZ does not undertake on-site bank examinations to review their lending practices or loan quality. In contrast, the Australian regulator — APRA — does routinely do this. It occasionally does this in New Zealand in respect of the Australian banks operating here.”

It could be argued, of course, that APRA’s vigilance hasn’t prevented misconduct in Australia but, equally, that things undoubtedly would have been a lot worse without its surveillance.

New Zealand banks say they check borrowers’ details carefully. BNZ, for instance, told NOTED: “Brokers interview the customer and collect all the information required to approve a home loan including documents to validate this information (e.g. statements, pay slips, letters from employers, IRD forms).

“Then the application and documents come to BNZ and our credit assessors validate the information in the same way as we do for applications from our direct branch channels. This process occurs for every loan.

“BNZ also does frequent spot checks on samples of our home loans which we call lending quality assessment.”

BNZ’s stated approach is the way things should operate but to maintain confidence in the banking system the public needs to know our financial regulators are on top of the issue. We shouldn’t have to rely on banks’ attestations of their good practice, as we do so often under our regulatory agencies’ light-handed approach. And especially not after the startling admissions at Australia’s royal commission and the widespread belief here that banks are so keen to lend money that it is easy to get away with fudging financial information.

An inquiry into the banks’ lending conduct would help reassure the public that our massive mortgage market of $248 billion is every bit as sound as the banks say it is.

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